Wednesday, September 30, 2015

Placement Agents: Part II: When Should You Use a Placement Agent, and How to Pick the Right One?

At this point, having discussed the services a placement agent can provide, the kinds of compensation used, and other important terms to keep an eye on when negotiating for the services of a placement agent, there is still the threshold matter of determining whether using placement agents makes sense (and when it doesn’t) in the first place. In addition, how to decide which specific placement agent to use?

The first thing to keep in mind is that placement agents are much more common in later-stage financing rounds. Placement agents are almost never used in seed rounds or early-stage financing. One reason for this is that the universe of potential early-round investors (e.g., VC firms and funds) is much smaller and, for lack of a better word, self-contained. In addition, pertinent information, such as what sorts of companies particular VCs invest in and at what dollar amounts, is often publicly available to a much greater extent than for later-stage investors. On a practical level, companies in the early fundraising stages may also be less willing or able to pay the significant commissions demanded by placement agents for their services. This does not mean, of course, that it is never helpful or necessary to use a placement agent in an early-stage fundraising round, but they are used much more commonly—and are in general much more helpful—in later-stage rounds by companies with some kind of established track record.

That being said, if an issuer feels that it can be successful in raising capital without employing the services of a placement agent (for example, perhaps it has only a few major investors who are willing to fully finance a later round), then there is nothing which requires that a placement agent be used. Any money not paid out to placement agents as commissions in a private placement is money the company retains for its own use.

Sometimes, however, using a placement agent is necessary or helpful. For example, if the company is contemplating multiple rounds of private placements over an extended period of time, hiring a placement agent that can introduce the company to a significant number of potential investors (and who may be willing to invest in multiple financing rounds) could be very beneficial. Obviously, if the company has had difficulty raising capital in the past or is facing low interest in the present, hiring a placement agent may be helpful. If conditions in the broader economy are difficult, the services of a placement agent may also be necessary. In the end, the decision whether to hire a placement agent will depend on the circumstances.

If you are considering using a placement agent, you will want to do your homework, as with any potential partner. From a legal standpoint, the most crucial requirement is that you only use a registered BD as a placement agent. This is because any BD acting as a placement agent will be deemed to be “participating” in the offering, and according to both SEC and FINRA regulations, only registered BDs are allowed to so participate. A company should be particularly wary of so-called “finders”, which are not registered BDs. A “finder” may offer to introduce companies to investors, but nothing else—they do no assist with the PPM, do not talk to investors on behalf of the company, etc. It is very important to keep in mind, however, that both the SEC and FINRA define “participation” very, very broadly, and if they find that non-registered persons have participated in the offering, the penalties can be severe, including, for example, “rescission” (i.e. returning any money accepted back to investors).

After making sure that the placement agent you use is a duly-registered BD, there are additional considerations to keep in mind. Some placement agents, for example, may specialize in certain kinds of companies (e.g. software companies or pharmaceutical companies), certain kinds of offerings or transactions (e.g. debt or equity offerings), certain kinds of investors, or certain regions (whether within the United States or with overseas investors). You should ask potential placement agents to put you in contact with other companies who have used their services in the past (though note that the particular terms, such as compensation, are likely covered by confidentiality). Information, as always, is power, and the more information your company can obtain about your potential placement agent partner, the more confident you can be that the placement agent you are partnering with will help you achieve your company’s goals.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Tuesday, September 29, 2015

Placement Agents: Part I: What Are They, What Do They Do and on What Terms?

Raising money for private companies can be a frustrating and stressful experience. Without the kind of access to the investing public that a public company enjoys, and given the kinds of restrictions on who can invest in many types of private placements, finding appropriate investors can be a daunting proposition. It can also be expensive, not only in terms of money but especially in terms of the time and effort required, time that you and your employees might otherwise put towards finding new clients, improving business processes, or creating new products.

For those who want assistance in the fundraising process, one option is to engage a registered broker-dealer to act as a placement agent for the offering. This blog will discuss the role of placement agents in the fundraising process.

What is a placement agent and what can they do?

Essentially, a placement agent is a registered broker-dealer (a “BD”) that assists the company offering the securities (the “issuer”) by connecting it with qualified investors who may be interested in purchasing the issuer’s securities. One of the primary benefits of using a placement agent is the ability to quickly gain access to potential investors with whom the placement agent enjoys a pre-existing relationship. Out of its long list of qualified investors, the agent can help identify those potential investors who are likely to be interested in this particular investment opportunity. This ability to identify qualified potential investors and target those most likely to invest improves the chances that the company will be successful in raising the levels of capital it is seeking. In addition, reliance on the agent’s pre-existing relationships with investors helps the issuer avoid violating restrictions on general solicitation and advertising if conducting Rule 506(b) private placement.

A related function of the placement agent in a private placement is to assist the issuer in preparing and distributing its private placement memorandum (a “PPM”) to potential investors. The PPM is an informational document provided to potential investors, and fulfills a similar function as does a prospectus in a registered public offering (this document is sometimes also referred to as an “offering circular” or “offering memorandum.”) The PPM will include material information about the company, such as its history and description of the company’s business, financial disclosures, and investing risks. Like a prospectus, the PPM serves a dual role as both a marketing document and a liability reduction document, and is thus of tremendous importance in the private placement. Having the assistance of a reputable placement agent in drafting this document can be of great benefit for the company.

Related to assisting the company in preparing the PPM, the placement agent can also provide assistance more generally with its marketing and capital-raising efforts. For example, the placement agent can provide assistance in preparing and putting on investor “road shows”, drafting communications like press releases or investor updates, and similar activities. Not all BDs acting as placement agents will offer the same services, of course, and the specific services required by an issuer for any single capital raise will vary; the particulars of any agreement between the issuer and its placement agent can be negotiated and developed when the issuer decides to contract with the placement agent for its services. On that note, I will next discuss the issue of placement agent compensation, as well as some of the common areas of negotiation which tend to arise when negotiating the contract for placement agent services (usually called the “placement agency agreement” or “engagement letter.”) Often, placement agents will have pre-drafted forms of these agreements. Some terms, such as indemnification and liability limitations, are generally non-negotiable, whereas terms like compensation, exclusivity, and the length of the tail provision, are negotiated based on deal specifics.

Placement Agent Compensation

By far the most common form of compensation a BD serving as placement agent will take is in the form of commissions, much like an underwriter in a registered public offering. The commission percentage charged on any particular deal is negotiable, naturally, but in general will range from around 7% at the lower end to about 15% at the higher end. This commission is charged on the total amount raised, which depends in turn on how many shares the agent can place with investors. For example, if the placement agent succeeds in placing 100,000 shares at $1 per share with its investors, and its commission is 8%, its compensation will be $8,000. Some common variations to a static percentage rate might include a tiered structure (for example, the agent might earn 7% for the first 100,000 shares placed, 10% for the next 200,000, etc.) or a rate that depends on the overall success of the private placement (e.g. the BD receives 9% if the placement raises $1 million or less, but 11% if it raises more than that.) Again, commission compensation will be a basic negotiating point in any placement agency agreement.

In addition to commission fees, placement agents will sometimes request equity compensation, most often in the form of options or warrants to purchase shares at a particular price. Outright allocations of shares is less common, although not unheard of (sometimes, for example, when the capital raise has been particularly successful, the company will give the BD a small number of shares in the form of a “success fee,” although contractually this is often left to the company’s discretion.)

If the private placement is to take place over an extended period of time, and particularly if the placement agent will also be providing some of the more general services alluded to in the above section, compensation may also include an initial retainer fee or monthly service fees. Like commission-based compensation, these amounts are negotiable. If these fees are included as compensation, one possibility, for example, might be to structure the contract such that these fees will be offset against commission compensation.

“Best Efforts” Offerings

Placement agents, like underwriters in a public offering, are primarily compensated based on the commission model. A major difference between the two is that underwriters in public offerings are almost always engaged with on a “firm commitment” basis, whereas placement agents in private placements almost always work on a “best efforts” basis. Simply put, this means that the placement agent does not guarantee that it will be successful in placing all of the issuer’s shares, or even a particular number of shares, and it does not agree to purchase itself any shares it cannot place with investors. (In a “firm commitment” underwriting, on the other hand, the underwriter promises that it will purchase for its own account any shares it cannot place with investors.) Instead, it only promises to use its “best efforts” to place as many shares as it can (ideally, of course, it will place all of them, because the more it can place, the greater its commission compensation.)


Issuers may wish to engage the services of several placement agents in a single offering (similar to using an underwriting “syndicate” for a public offering.) This raises the issue of exclusivity. Simply put, if an issuer engages with a placement agent on an exclusive basis, the company is agreeing that it will not use any other placement agent for that offering. If the agreement is non-exclusive, the company may use other placement agents for that offering. In that case, it is imperative to maintain accurate records as to which agents are responsible for which investors. Generally, if multiple placement agents are used, the company will likely want to engage each on roughly equal terms (particularly in terms of commission rates), primarily to avoid engendering any bad blood. Neither exclusivity nor non-exclusivity is objectively better than the other, and will depend, as with other aspects of the agreement, on the particulars of the offering.

The Tail Provision

Often, the agreements between issuer and placement agent are terminable by either party with or without cause, provided sufficient notice is provided. Because of this, placement agent will virtually always insist on what is known as a “tail” provision that says that even if its services are terminated prior to the closing of the offering, the placement agent will be entitled to compensation if an offering takes place within a specified time period. The amount of compensation is generally what the agent would have been entitled to if its services had not been terminated (i.e. if the company sells to investors originally introduced to it by the placement agent, it will be entitled to its commission compensation for those investors.) The purpose of this provision is, essentially, to protect the agent from an unscrupulous issuer exploiting its connections with investors but terminating the relationship prior to the actual offering so as to avoid being required to pay the placement agent its commission fees. It is virtually impossible to eliminate the tail provision from the placement agent agreement, but the particulars, such as the length of the tail or what counts as a successful closing, may be amenable to negotiation to some extent (for example, if the issuer cancels one offering, then launches another one within the time frame and makes an offer to an investor originally introduced in the prior, canceled offering by the terminated placement agent, is it still entitled to compensation?) As a practical matter, the company will prefer the shortest possible tail, while the placement agent will want one as long as possible. In my opinion, any tail of over 1 year is entirely unreasonable, and in no event should an issuer agree to an open-ended tail, which is not unheard of in agreements drafted by placement agents.)

Additional Provisions

Terms related to compensation, exclusivity, and the tail provision are commonly negotiated terms, but they are of course not the only important provisions of the placement agent agreement. Representations and warranties are very important as well; the placement agent will want to ensure that any information the company is providing to it is accurate, while the company will want to make sure that the placement agent is legally permitted to provide the services it is offering (i.e. that it is duly registered with the SEC, FINRA, and any applicable state agencies), that it does not have any “bad actors” participating on the deal, that it has a pre-existing relationship with any investors it is contacting in connection with the deal (and that it certifies to the company that such investors are qualified to participate in the offering), etc.

In summary, with regards to the placement agency agreement and its terms, the company should be sure to make use of the services of an experienced attorney.

In the next blog, we will discuss whether issuers should use placement agents, and how to choose the right one.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Thursday, September 17, 2015

Citizen VC No-Action Letter - the SEC Guidance on Online Private Placements

As a follow up to my previous blog post where I discussed the new CDIs relating to the definition of "general solicitation" in private offerings conducted under Rule 506(b), I decided to discuss the recently issued SEC no-action letter to Citizen VC.  This no-action letter is all about the application of the new SEC guidance regarding general solicitation in practice.  This can serve as a useful tool for conducting private placements over the Internet.

The main question was the establishment of a "substantive pre-existing relationship" between CitizenVC and prospective investors that would allow the issuer to conduct Rule 506(b) private placements without engaging in general solicitation.  The definitions of "substantive" and "pre-existing" were recently clarified by the SEC (CDI Questions 256.26-31).  According to the SEC (CDI Questions 256.29 and 30), a "pre-existing" relationship is one that is established prior to the commencement of the offering.  There is no minimum waiting period so long as the relationship was established before the offering started.  According to the SEC (CDI Question 31), a "substantive" relationship is one where the issuer "has sufficient information to evaluate, and does in fact, evaluate, a prospective offeree's financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor."

Now, let's take a look at the facts described in the CitizenVC request for the no-action letter.

CitizenVC is an online venture capital firm that offers LLC membership interests in SPVs formed for the purpose of investing into emerging growth companies.  The offering is done through their website.  CitizenVC intends to conduct the private placements under Rule 506(b) that does not allow the use of general solicitation.  To avoid general solicitation, CitizenVC first seeks to establish substantive relationships with its prospective investors.

First, the CitizenVC website that is viewable by the general public does not contain any information that could be viewed as an "offer".  There is no information about the current SPVs, portfolio companies, investment opportunities or offering materials.  This is consistent with the SEC guidance (CDI Questions 256.23-25) that states that the use of a publicly available website that contains an offer of securities constitutes a general solicitation.  To avoid this, the issuer should only disclose "factual business information that does not condition the public mind or arouse public interest in a securities offering" by that issuer.

Second, all visitors to the site that are interested in becoming a member of an SPV must complete an online accredited investor questionnaire.  Only those members who self-certify themselves as "accredited" will eventually receive a password that will allow them to access restricted portions of the site.

Third, CitizenVC implements its pre-set procedures (that contain six separate steps) to establish a substantive relationship with the prospective investor, including (1) contacting the prospective investor offline to discuss their experience and sophistication and to answer questions; (2) sending an introductory email; and (3) using third party credit reporting services to confirm identity and gather additional financial information and credit history information.  Once CitizenVC is satisfied that the prospective investor has sufficient knowledge and experience in financial and business matters and that a substantive relationship has been created, it will admit him or her as a member of the website and send a password to the "member only" areas of the website that contain investment opportunities.

Once enough members indicate interest in an opportunity, CitizenVC will create an SPV to aggregate such members' investments.  Members will be given subscription materials that will contain additional risk disclosures and detailed accredited investor certifications and representations.

The most important aspect of this no-action letter is that the issuer has no minimum waiting period to establish a substantive relationship with a prospective investor.  For CitizenVC, it is the question of quality of such a relationship rather than its duration.  Completion of a "check the box" accredited investor questionnaire alone does not establish such a relationship.  On the other hand, a 30-day waiting period is also not necessary (See Lamp Technologies No-Action Letter).  As the SEC confirmed in its response to CDI Question 256.31, a "substantive" relationship is established when the issuer "has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree's financial circumstances and sophistication."  That may take a week or a month, depending on the circumstances.

In conclusion, the CitizenVC no-action letter offers an excellent step-by-step guide on how to conduct online private placements in compliance with the requirements of Rule 506(b).  All issuers currently structuring their investment platforms should closely study and analyze this example.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.